Competition and Market Structures 7.1 Competition and Market Structures

Objective Explain the characteristics of perfect competition Understand the nature of monopolistic competition Describe the behavior and characteristics of the oligopolistic Identify several types of monopolies

Vocab Laissez-faire Collusion Market structure Price-fixing Perfect competition Imperfect competition Monopolistic competition Product differentiation Nonprice competition Oligopoly Collusion Price-fixing Monopoly Natural monopoly Economies of scale Geographic monopoly Technological monopoly Government monopoly

Introduction When Adam Smith published An Inquiry into the Nature and Causes of the Wealth of Nations in 1776, the average factory was small, and business was competitive. Laissez-faire, philosophy that government should not interfere with commerce or trade, dominated Smith’s writing French for “allow them to do”

Under Smith’s train of thought, the role of government is confined Protecting private property Enforcing contracts Settling disputes Protecting businesses against increased competition from foreign goods

By the late 1800’s competition was weakening. As industries developed (supply side of the market, producers) the nature of competitive markets changed.

They ask questions such as Today, economists classify markets according to conditions that prevail in them. They ask questions such as How many buyers and suppliers are there? How large are they? Does either have any influence over price? How much competition exists between firms? What kind of product is involved-is everyone trading the exact same product, or are they simply similar? Is it easy or difficult for new firms to enter the market?

Economists group industries into four different market The answers to these questions help determine market structure, or the nature and degree of competition among firms operating in the same industry. Economists group industries into four different market Perfect competition Monopolistic competition Oligopoly Monopoly

Perfect Competition Perfect competition is when a large number of buyers and sellers exchange identical products under 5 conditions. 1)There should be a large number of buyers and sellers 2)The products should be identical 3)Buyers and sellers should act independently 4)Buyers and sellers should be well informed 5)Buyers and sellers should be free to enter, conduct, and get out of business

Under perfect competition, supply and demand set the equilibrium price, and each firm sets a level of output that will maximize its profits at that price. Imperfect competition refers to market structures that lack one or more of the five condition of perfect competition.

Monopolistic Competition Monopolistic competition meets all conditions of perfect competition except for identical products. Monopolistic competitors use product differentiation—the real or imagined differences between competing products in the same industry.

Monopolistic competitors use nonprice competition, the use of advertising, giveaways, or other promotional campaigns to differentiate their products from similar products in the market. Monopolistic competitors sell within a narrow price range but try to raise the price within that range to achieve profit maximization.

Oligopoly Oligopoly is a market structure in which a few very large sellers dominate the industry. Oligopoly is further away from perfect competition (freest trade) than monopolistic competition. Oligopolists act interdependently by lowering prices soon after the first seller announces the cut, but typically they prefer nonprice competition because their rival cannot respond as quickly.

Oligopolists may all agree formally to set prices, called collusion, which is illegal (because it restricts trade). Two forms of collusion include price-fixing, which is agreeing to charge a set price that is often above market price dividing up the market for guaranteed sales.

Oligopolists can engage in price wars, or a series of price cuts that can push prices lower than the cost of production for a short period of time. Oligopolists’ final prices are likely to be higher than under monopolistic competition and much higher than under perfect competition.

Monopoly A monopoly is a market structure with only one seller of a particular product The United States has few monopolies because Americans prefer competitive trade, and technology competes with existing monopolies. Natural monopoly occurs when a single firm produces a product or provides a service because it minimizes the overall costs (public utilities). Geographic monopoly occurs when the location cannot support two or more such businesses (small town drugstore).

Technological monopoly occurs when a producer has the exclusive right through patents or copyrights to produce or sell a particular product (an artist’s work for his lifetime plus 50 years). Government monopoly occurs when the government provides products or services that private industry cannot adequately provide (uranium processing). The monopolist is larger than a perfect competitor, allowing it to be the price maker versus the price taker.